Biodiversity: The Missing Piece in the ESG Puzzle

Sustainability efforts to date have focused overwhelmingly on climate change. They typically involve the measurement and management of carbon emissions, which is a good step, but one which misses a significant piece of the sustainability puzzle.

If investors take the same steps in biodiversity as they have in carbon emissions reporting and mitigation, their portfolios would be more sustainable and they could better mitigate their ESG risks.

Why is Biodiversity Relevant to Investors?
Biodiversity is what makes life possible. Our livelihoods depend upon it, as do our economies. It is estimated that between 15% and 45% of world GDP is directly linked to biodiversity.

Agriculture and food in particular have a high impact on biodiversity. These two sectors are responsible for 26% of global GHG emissions, while 60% of biodiversity loss is caused by agricultural practices.

The current debate on sustainability has led investors to focus predominantly on energy, utilities and transportation, and these sectors have seen huge sustainability improvements in recent years, mainly relating to climate change mitigation.

Agriculture and food are less visible because there are fewer IPOs, less attention in the media and consequently less awareness among investors. In part, biodiversity has not entered the public consciousness to the same extent as climate change because of the difficulty of measuring it.

While biodiversity – the quantum of existing animal and plant species – is simple to grasp as concept, it is not so simple to measure. A ton of CO₂ produced in China, has the same impact on climate change as one produced in Brazil or France. But producing 1kg of meat in one of these countries has very different biodiversity impacts because of the differences in the local ecosystem, farming practices, logistics networks, land uses and so on.

A robust measurement of biodiversity is essential if biodiversity is to be meaningfully integrated into investor portfolios.

Metrics for Measuring Biodiversity
To date, investors have reported on biodiversity by looking at qualitative data such as companies’ commitments, or ESG scores relating to biodiversity, such as corporate procedures and policies.

A more effective way to measure biodiversity impact is to use physical metrics in the same way that tons of CO₂ have become a standard measure for measuring impact on climate. Only with hard numbers can companies reliably monitor their biodiversity performance, measure it against competitors and report it to investors.

Mean Species Abundance (MSA) is probably the best existing indicator for capturing and quantifying a company’s impact on biodiversity. MSA measures the difference in diversity before and after a corporate activity. This difference is expressed as the loss in biodiversity relative to the “undisturbed” natural state.

Analysing the Full Value Chain
Integrating the biodiversity through the MSA indicator in portfolio construction allows a robust quantitative approach to ESG investing. It enables a response to questions such as: how much biodiversity loss can be attributed to the production of 1kg of beef or 1 litre of milk?

Loss of biodiversity due to the food sector can be broken down into four main factors:

1. Land use. The change in biodiversity as forests are converted to farmland.
2. Climate change. The amount of greenhouse gases emissions.
3. Nitrogen oxide emissions. Mainly linked to fertilisers.
4. Water. The amount of freshwater eco-toxicity.

When a company is measured on these key factors, they can be given an aggregate score which represents their biodiversity footprint. Assessment must include the full value chain, from raw material producers, to the transformation of commodities to products, logistics, packaging, and finally to retailing via supermarkets and restaurants.

Clearly granular data is required for this. Some of this data is found in company disclosures, particularly in the few jurisdictions where regulations demand biodiversity reporting. But where disclosure is lacking, proxy models can be created. For instance, McDonald’s does not disclose how much meat it sells in each market. “But we can proxy total sales for each market, and you can map this with meat sourcing and local biodiversity, so you can estimate its biodiversity footprint reasonably well,” says Carmine de Franco, Head of Research at Ossiam, an affiliate of Natixis Investment Managers.

Initiatives for the reporting of biodiversity are underway in France and the Netherlands, and are being considered in other countries. “Just as carbon footprint reporting has been mandatory in many countries, so biodiversity reporting is likely to become mandatory over time,” adds de Franco.

Systematic Application of a Range of ESG Metrics
Since the high-stakes players in biodiversity are in the food and agriculture sectors, the universe of companies for a biodiversity strategy is confined to these sectors. This implies an investment universe of around 250 companies listed in developed markets, whose principal business is related directly or indirectly to food and agriculture.

Companies are selected using a series of quantitative filters. The first removes the bottom 20% of companies ranked by ESG food scores. The next filters remove the worst performing GHG-emitting stocks, controversial companies, companies in breach of the UN Global Compact, tobacco and palm oil stocks.

The final step aims at reducing as much as possible the biodiversity footprint of the portfolio using the MSA metrics. The process is then supported by engagement with investee companies to pursue tangible changes and concrete outcomes.

De Franco says: “In this way, you apply many ESG metrics to a single strategy, with each metric capturing a different ESG issue. You end up with companies that have high ESG awareness, carbon efficiency, low biodiversity impact and, through engagement, companies that commit to do more.”

Resulting Portfolio is Defensive
The resulting portfolio has high exposure to consumer staples and consumer discretionary, which are defensive sectors with low beta, and thus perform well in volatile markets (although the strategy tends to lag in strong bull markets that are driven by technology, energy and financials). “We would not expect this strategy to perform like technology or other high-growth strategies, but agriculture and food is expected to grow in order to meet the demands of a world population that is forecasted at 11bn by the end of the century,” says de Franco.

Population growth will be accompanied by a change in diet amid the rise of wealthier middle classes in emerging markets. “The combination of population growth and changes in consumption patterns puts a lot of pressure on biodiversity, as middle-class families in developing countries improve their diets and increase their consumption of dairy and meat, making our strategy very relevant,” adds de Franco.

There is already growing public recognition of this pressure on biodiversity. In Europe alone, EU Commission President Ursula Von der Leyen, President Macron of France and Christine Lagarde, president of the European Central Bank, have all recently warned about the impact on biodiversity and natural capital. Meanwhile, the World Economic Forum rated biodiversity loss as the second most impactful risk over the next decade. And the UN PRI has said biodiversity loss is a systemic risk, requiring urgent action by investors.

Regulators are starting to act too, with the implementation in France of disclosure regulation on climate-related issues being supplemented recently by laws on the reporting of biodiversity risks.

Conclusion: Investors Have Power to Set Tangible Targets
Investors can play a leading role in preventing damaging biodiversity loss by engaging with companies and pushing them to improve their practices. They can set ambitious, tangible targets for companies to promote a culture of biodiversity awareness and invest based on a company’s impact.

“To improve your sustainability score you can invest in many technology companies, and that’s fine, but it won’t solve any sustainability problems,” says Ossiam’s de Franco. “Alongside our investors, we want to have a big impact on sustainability. This means not running away from problems, but identifying the companies that can make the biggest contribution to protecting biodiversity.”